Interest rates have been a hot topic in Australia lately, and for good reason with the Reserve Bank of Australia steadily rising rates since mid 2022.
Right now, the media seems fixated on something called the 'fixed rate mortgage cliff’. But just what is it, do we need to be worried and how do we prepare?
In this article, co-host of the 26 and Sunny Podcast, Cat Denney, takes us through the current interest rate environment and what it means for your loan repayments. A Northern Beaches mortgage broker, Cat has a wealth of experience helping people navigate the home lending market.
Find out whether you're at risk and, if so, what you can be doing now to prepare for the future.
What is the fixed rate mortgage cliff that we’re hearing so much about?
Many people fixed their mortgage at low rates – around 2% - before the Reserve Bank of Australia (RBA) started hiking them up. As those fixed periods come to an end, hundreds of thousands of mortgages will roll off their cushy low rates and onto much higher rates. For a large chunk of them, this is due to occur between May and November.
For people rolling off their fixed periods right now, they’ll be looking at an interest rate in the high 4s to mid 5s. In a few months' time, assuming the RBA dishes out a few more rate rises, they might be looking at mid 5s to low 6s.
Commentators in the market are worried that many of these people will struggle to meet their repayments at the higher interest rate.
What impact will it have on the monthly household budget?
Great question. Let's take a look at two examples.
A household with a $750,000 mortgage at 2.14% (the average owner-occupied fixed rate between the onset of the pandemic and the end of 2021) was spending $2,825 a month on their loan. If they roll off onto a new variable rate of 5.5%, for example, they will be paying $4,258 a month - $1,400 or so more.
But mortgages on the Northern Beaches are much bigger, and on a $1.4m mortgage at 2.14%, you’d be paying $5,273 a month. When that pushes up to 5.5%, those mortgage holders will be looking at $7,949 a month - $2,676 a month more.
You also have to remember that other living costs are also going up – utilities, groceries, petrol – so it's not just mortgages that will be putting pressure on household budgets.
Will this put downward pressure on house prices?
It's hard to say. Some commentators are optimistic – people typically do all they can to hold onto their homes. Others are more pessimistic, predicting that many will be forced to sell.
Of course, if we get a lot of forced selling, then it's a fair assumption that it will have a negative impact on property prices.
But didn’t lenders stress test people when they took out the mortgage? I thought lenders allowed for increases in their borrowing capacity calculations?
Absolutely, lenders always test borrowing capacity at a higher rate. It's called a 'Buffer Rate.' When a bank assesses whether you can afford the proposed home loan, they add a buffer to the actual interest rate to test you.
Prior to October 2021, the minimum buffer rate required by ASIC was 2.5%. But it was upped to 3% at that point. So, if you were one of the people who fixed their loan at 2%, then you were assessed on 5%. If these people are now facing rates of 5.5 – 6% later this year, then they've already surpassed the stress test.
So do you think lots of people will refinance to get a lower rate?
Some will succeed. But many people will find they no longer qualify for the loan they have. This could be for one of two reasons.
One, if you borrowed a high amount compared to the value of the property, there is a good chance that you would find yourself in Lenders Mortgage Insurance territory if you tried to move lenders because house values have declined.
Two, many people will find they no longer qualify for the loan they have. Your bank might have originally approved you for a $750,000 loan, for example, when rates were around 2%, but now they will be assessed on rates of 5%. At this level, many won’t pass the servicing test.
So I think many people will find they’re stuck - it’s a situation we call mortgage prison.
What can people do to get through this period?
There are a few things you can do to take the pressure off. One, push your bank for a lower rate. Start by benchmarking their competitors, find a comparable product that is lower than yours and get on the phone. Your broker can also submit pricing requests on your behalf. If they won’t come down, then consider refinancing to a lower rate if it’s an option to you.
Two, if your rate is currently fixed and you’ve still got a little while until it swaps to variable, start putting away extra cash now in preparation for the end of your fixed rate period. This will create a pool of money you can use down the track if needed.
Three, take a look at all of your spending to identify non-essential items that you really can live without for a little while. I see people spending a lot on entertainment, takeaway food and television streaming services – luxuries that we can live without if needed.
Finally, utilise your offset account to the max. Get your salary paid into it. Put all your savings in it. Every dollar against your mortgage helps reduce the interest you pay.
Finally, what can people do if they cannot make their repayments?
Talk to your broker and talk to your bank. Banks want to help you and have various hardship measures they can offer. The key – and this is critical – is to speak to them early before you miss a repayment. This shows that you are responsibly managing your money and your debt.